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FMBI earnings call for the period ending March 31, 2019.

Contents:

Prepared Remarks

Questions and Answers

Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen and welcome to the First Midwest Bancorp 2019 First Quarter Earnings Conference Call. Following the close of the market yesterday, the Company released its earnings results for the first quarter of 2019 and also issued presentation materials that will be referred to during the call today.

These provide both historical financial information and the Company's outlook for 2019. During the course of the discussion today, management's comments and the presentation materials may include forward-looking statements.

These statements are based upon the Company's current beliefs and are not historical facts or guarantees of future performance or outcomes. Actual results or outcomes may differ. The risks, uncertainties and Safe Harbor information contained in the Company's most recent 10-K and other filings with the SEC, as well as the forward-looking statement, non-GAAP and other legends included in the Company's earnings release and presentation materials should be considered for the call today.

Finally, the Company will not be updating any forward-looking statements after this call. This call is being recorded and all participants are in a listen-only mode. Following the presentations by Mike Scudder, Chairman and Chief Executive Officer; Mark Sander, President and Chief Operating Officer; and Pat Barrett, Executive Vice President and Chief Financial Officer, the call will be opened for question and answers for analysts only.

Thank you. Good morning, everyone. I greatly appreciate you joining us today, it's great to be with you. I want to point out once again that we have provided a supplemental presentation that you can follow along with as we move through our remarks, and as is our practice, I'll cover the highlights and then Mark and Pat can walk you through the components.

Overall, the first quarter was solid, active on multiple fronts and reflective of what we typically see in terms of seasonality for the first quarter as well as the impact of market volatility on certain of our fee-based businesses. Overall, the quarter was very much in line with where we expected it to come in and we feel pretty good about where we're at.

Earnings per share totaled $0.43 up 30% from last year, 10% from the fourth quarter of 2018. Adjusted earnings per share was $0.46, that's up almost 40% versus a year ago, and as expected, it's down seasonally about 4% linked quarter.

Adjusted return on tangible common equity will remain strong for us at 15.3% and also was somewhat influenced by the fact that we kicked off our sale leaseback accounting treatment this quarter, which added an incremental amount of capital to us this year, all very positive.

Key business drivers of note, loans outstanding increased 4% annualized over the linked quarter, up almost 8% versus a year ago. Our average deposits increased by 10% over the last year with core transactional deposits remaining at a very strong 78% of our total deposits. Operating metrics were also strong. Margin cleared 4% for the first time in a long time coming in at 4.04%, that's up 24 basis points and 8 basis points versus last year and the fourth quarter respectively.

Similarly, operating efficiency came in at 56%, stable with fourth quarter levels and improved by almost 10% versus a year ago. Combined, that performance helped to offset lower fee based revenues as I said before, certain market volatility weighed on certain segments.

In addition, we have made or are making several investments that better position us even as we move forward. Our acquisition of Bridgeview Bank will close and systems will convert in mid-May, that will add about $1 billion in deposits and $800 million in loans; 13 banking offices and most importantly a very talented team to our overall metro Chicago market.

A special thanks to both teams as they worked hard to put us in this great position to move forward, as I said in mid-May in close.

Our acquisition of Northern Oak Wealth Management also closed in January and added about $800 million in assets under management to our overall wealth platform. It also marked our entry to the Milwaukee marketplace, and recognizing that we've continued to incrementally build a commercial presence there, we added a team of -- adding a team of three commercial lenders in that market.

Finally, our balance sheet and capital remains very strong. Our Tier 1 common to risk-weighted assets has grown 32 basis points to over 10.5% and reflects as I said before the benefit of the sale leaseback accounting, which will allow us to effectively absorb Bridgeview when it closes in May.

Combined with strong earnings, we have the flexibility to continue to grow, operate within our dividend guidelines as well as appropriate -- as it's appropriate execute on our recently announced repurchase program. So all in all, it was a very busy and productive quarter and I'll turn it over to Mark and Pat for additional color.

Mark G. Sander -- President and Chief Operating Officer

Thanks Mike and good morning everyone. Before I start I want to note that with our acquisition expected to close on May 9th, we've incorporated Bridgeview into all of our guidance. So, we summarized that guidance on Slide 11 of our deck and we detailed it for each area that Pat and I will discuss, as we take you through our quarterly performance and future outlook.

Beginning on Slide 3 of the deck, loan growth of 4% annualized was in line with our expectation given Q1 is our seasonally slowest period. Results were a continuation of the themes we've discussed for several quarters now namely strong C&I growth and consumer growth more than offsetting outsized CRE payoff pressures. We again saw a heavy sale and refinance activity from investors and non-bank lenders and combined with lighter CRE production in Q1, this segment fell slightly. Elsewhere, several teams again posted very solid results.

Our middle market, specialty, and consumer segments in particular added new relationships such that total loans grew $120 million despite the CRE pressures. In light of our solid pipelines, our view after the full year is unchanged such that adding Bridgeview should result in aggregate loan growth of high single to low double digits.

I want to note and add to Mike's comments that we're very excited to officially welcome our new Bridgeview team members to the First Midwest family here in a few weeks.

Across the board, these client facing teams have impressed us in terms of their talent level and their very positive approach and together we think we can help them expand further. Asset quality, as demonstrated on Slide 4, remains solid. Charge-offs of 32 basis points and provision of $10.4 million were in line with our expectations and guidance.

We did see a slight uptick in NPAs, but nothing of serious concern. We will continue to closely watch our ag and our other elevated risk sectors closely, but again we're not seeing anything to alter our outlook.

We believe charge-offs will be in the low to mid 30 basis points range for the rest of the year. Moving to Slide 5, deposit levels and costs remain a key strength of our franchise as Mike highlighted. Demand deposits have held steady over the course of the last year due to the nature and granularity of our client bases. We also continue to be competitive on rates, which in conjunction with strong sales disciplines drove a $330 million increase in average time deposits this quarter to support loan growth.

Due to our favorable mix, overall cost of deposits of 55 basis points remains a competitive advantage, historically of about 25 basis points to 30 basis points which helps drive our favorable margin, as Pat will detail in a minute. Our core deposit scale and focus and the strategies to drive it, remain at the forefront of our sales goals, while acquisitions continue to add further funding.

Thanks, Mark and good morning to everyone on the call. Turning to net interest income and margin on Slide 6, net interest income was consistent with the prior quarter at $139 million and up $21 million or 17% compared to the same period in 2018.

Compared to the prior quarter, the impact of higher rates and acquired loan accretion was offset by higher funding costs and fewer days in the quarter. The increase compared to the same period a year ago was due to the acquisition of interest earning assets from NorStates, higher interest rates, growth in loans and securities, and higher loan accretion partly offset by higher funding costs. Acquired loan accretion contributed $6.5 million to the quarter, $1.5 million higher than expected due to favorable acquired loan resolutions.

Moving to net interest margin, tax equivalent NIM for the current quarter of 4.04% was up 8 basis points linked quarter and 24 basis points from the prior year. Excluding accretion, margin was 3.86% for the quarter, up 5 basis points linked quarter and 22 basis points from the same period a year ago. Compared to both prior periods, the benefit of higher interest rates more than offset the impact of higher funding costs.

Performance for the current quarter was better than our guidance reflecting more favorable funding costs than we had anticipated.

Turning to earning assets and funding sources, average interest earning assets were consistent linked quarter and up $1.3 billion compared to the prior year reflecting loan and securities growth combined with earning assets from the NorStates acquisition. Average funding sources were consistent linked quarter and up $1.2 billion from a year ago reflecting increases in time deposits as well as the impact of NorStates.

Moving to our 2019 outlook, we have revised our interest rate forecast to reflect market expectations of no additional Fed rate hikes into 2019. We had originally assumed two rate hikes this year, one at midyear and another at year end. Overall, we don't expect this revision to result in a significant impact to net interest income, but may result in us being modestly lower still within our guidance range of low-to-mid double digit growth for the year.

One item of our outlook that likely will change as a result of our revised rate forecast is net interest margin, which may contract over the remainder of the year as a result of the Bridgeview acquisition, lower rate expectations, and actions we may take to react to the revised rate forecast and reduce our positive exposure to rising rates.

These actions could include adding incremental fixed rate earning assets off balance sheet instruments or combination of both. Once again, I want to remind you that projections are subject to volatility due to movements in interest rates, the pace of loan growth, and the impact of acquisitions. Now, I'll turn it back to Mark to discuss non-interest income.

Mark G. Sander -- President and Chief Operating Officer

Thanks, Pat. Non-interest income largely reflected seasonal softness in Q1. Thus, our outlook for the remainder of the year has not changed. Mortgage Servicing valuations were impacted by the shift in rates resulting in a $1.1 million or 3% comparative decline in total fee income year-over-year. In addition, a weak year-end stock market negatively impacted wealth revenues while swap income was softer consistent with CRE production in Q1.

We believe all three of these dynamics will look different for the remainder of the year, allowing the strengths in several areas that we've previously highlighted to drive favorable comparisons going forward. Specifically, we see deposit service charges increasing modestly for the full year as continuing solid treasury management results and the additional Bridgeview more than offset lower overdraft fees.

Wealth Management comparisons going forward should be even better than the 6% increase we posted in Q1, as quarter end market valuations recovered and along with continuing strong sales results and a full year contribution from our Northern Oak acquisition should drive revenues higher. Card-based fees are expected to continue the favorable comparison we saw in Q1, where our 11% year-over-year increase was half organic and half from acquisition.

And lastly, given our expectations for loan production and the impact of rates on MSR valuations, we think both swaps and mortgage revenue comparisons will be significantly more favorable in the next several quarters. In total then, our outlook for the remainder of the year is unchanged namely high single to low double digit full year growth in non-interest income.

Moving on to expenses on Slide 8. Please note the current quarter includes $4 million of acquisition and integration related expenses associated with the NorStates and Northern Oak acquisitions and to a lesser extent Delivering Excellence implementation costs.

Away from these items, total expenses were flat to the prior quarter as we achieved the full incremental benefit of delivering excellent expense initiatives while certain other spending initiatives were delayed until later in the year.

Efficiency ratio at 56% was consistent with the prior quarter and down from 61% a year ago. Our outlook for 2019 legacy expenses is unchanged, namely our fourth quarter 2018 run rate of $98 million, plus 3% inflation while our outlook for the impact of Bridgeview is also unchanged in $16 million with $4 million of additional expense expected in Q2 and $6 million in each of quarters three and four.

A last note on taxes before I leave this slide. Our effective tax rate for the quarter was 25% in line with our guidance. In 2019, our expected effective tax rate continues to be approximately 25%. Moving to capital on Slide 9, we continue to maintain capital at strong levels and are pleased at how rapidly we've earned back the capital we've deployed on recent acquisitions.

Our total capital and CET1 to risk-weighted asset ratios increased around 25 basis points from the prior quarter, reflecting the positive impact of the January 1st adoption of the new lease accounting rules combined with our earnings for the quarter, partly offset by the closing of the Northern Oak acquisition.

I'd also mention that during the quarter, we have received approval for a stock repurchase program of up to $180 million over a one year period, providing further capital deployment flexibility.

Turning to Slide 10. There is a recap on the details of our recently announced acquisition of Bridgeview expected to close on May 9th, which has been incorporated into our outlook. As a reminder, the transaction is expected to add around $0.11 to earnings by 2020. The economics of the transaction remain favorable with a relatively quick tangible book value earn back of approximately three years.

Okay. Thanks, Pat. So just to recap, we like where we're at. We've got a great position, we've got a strong balance sheet, engaged team of colleagues, and a solid underlying business momentum. So we've got the flexibility to manage our capital as well as continue to invest in our business and as always, we do so with an eye on how do we maximize long-term shareholder returns.

Bridgeview and Northern States will further set us apart as a market leader in metro Chicago, and as we've said on a couple of occasions, we're very excited to welcome our newest colleagues here to First Midwest. We're equally excited about Northern Oak, which has grown our wealth management platform to some $12 billion in assets under management. It also reinforces our opportunities for continuing expansion, as we look for business opportunities in the Milwaukee and southeast Wisconsin marketplace.

So with that as a recap, let's open it up for any questions you might have.

Questions and Answers:

Operator

Thank you, sir. The question-and-answer session will begin at this time. (Operator Instructions). The first question comes from Michael Young of SunTrust. Please state your question.

Michael Young -- SunTrust -- Analyst

Hey, good morning, everyone. I wanted to start off on just the loan growth pipeline maybe going forward into 2Q, you know, 1Q is always seasonally soft, but just curious how that's building and then any commentary on maybe the competitive dynamics of the market, now with some of the competitors gone, if that's changed at all?

Mark G. Sander -- President and Chief Operating Officer

Yeah. Thanks, Michael, it's Mark. You know, our pipelines are solid and growing as you suggested, Q1 is always seasonally softer, so we think that with nice solid pipelines, we can grow in that mid single digits organically like we have for the last several years.

You know competition is still fierce out there, but we think we can compete very effectively, certainly some of the disruption in the market, we continue to think provides opportunities, you know, their customers should be our prospects and so, you know, we just continue to do that daily blocking and tackling of calling and sales disciplines to drive those results.

So, we feel good about where we're at.

Michael Young -- SunTrust -- Analyst

Okay. And maybe one for Pat, just on kind of the ALCO positioning, I know you may have mentioned some potential shifts or things that may be being evaluated there, I know you guys do kind of a forward swap on parts of the book. Does any of that change or shift with kind of the shape of the yield curve now? Or are you evaluating any new opportunities there?

Yeah. I think it has shifted a little bit. We've said in the past that as we reach a point, where we think we're at or nearing the end of the rate hike cycle that we would probably look to put on duration and kind of extend out our balance sheet just to protect against the potential for falling rates and kind of optimize where we are. And given the pretty dramatic shift in market expectations around rates over the last 90 days, we feel like we're at that point, if it's not permanent it's at least a pause for a while.

And so you probably would see us adding some duration to the balance sheet through a combination of on balance sheet and off balance sheet actions. I would point out that right now the way that the curve is shaped, it's unlikely we would do any incremental hedging or derivatives, just because everything is so far out of the money, it wouldn't make a lot of sense.

Michael Young -- SunTrust -- Analyst

Great. And if I could, just one last one on capital. You know, you had the big bump from the sale leaseback this quarter and the accounting treatment and announced the share buyback, can you just maybe talk about your thoughts around utilization of that, what's the governor there, if there's a target capital level you're trying to get to over a medium period of time?

Right. Well, I think we're kind of at a level that we're very comfortable with right now. The benefits of the sale leaseback accounting will essentially fund the capital that's used for our acquisitions that are either the Northern Oak, which is already behind us or Bridgeview that's coming in the second quarter. So, really the share repurchase is just to give us the added flexibility and additional tool to help manage any excess capital accretion that occurs going forward.

Michael Young -- SunTrust -- Analyst

Okay. Thanks.

Operator

Our next question comes from Chris McGratty of KBW. Please state your question.

Chris McGratty -- KBW -- Analyst

Hey, good morning. Pat, maybe a question for you on the NII guide, you know, the low-to-mid double digit growth. Could you just speak around the bookends of that? What kind of a scenario would it take to be at low end versus the high end, you are talking a little bit lower on margin, but you didn't change the NII guide without the rate hike. So, I guess maybe you could speak to bookends. Thanks.

Right. So, our sensitivity to rate hikes has diminished over time. At one point, every rate hike was $3 million of NII. That's kind of shrunk over time to about $1.5 million. So we've revised downwards due to that. We do think that we can take some actions to recover some of that if not all of that over the course of the year, and part of that may well be some balance sheet repositioning.

So while on the surface you would think NII as an exact number would have drifted down a little bit, it is still well within our range of guidance, which is already up (ph). That makes sense?

Chris McGratty -- KBW -- Analyst

I think so, maybe I feel little bit differently, I guess the duration comments of lengthening, should we be expecting kind of more growth in the investment portfolio to get to this target?

That certainly would be the obvious and the easiest option for us to put duration on, yes.

Chris McGratty -- KBW -- Analyst

Okay. And then maybe just going back to the buybacks. You know, $100 million is obviously a one year authorization of the common stock given liquidity. Can just speak to kind of targets -- longer term targets and how you're thinking about managing it. You know, should we as analysts put a portion of this into our estimates to kind of manage the capital from running away from us? I'm just trying to get a sense of kind of urgency with the buyback. Thanks.

Right. Well, I think I'll answer the second part first. There's not a sense of urgency around it. This is something that it's been 12 years since we've had a buyback program in place. We've reached capital levels that we're comfortable that we're able to fund our growth and modest acquisitions, and continue to throw off you know somewhere in the 15 basis points to 20 basis points of additional capital every quarter after our dividends and so we -- we're maintaining our capital levels we're at now, which is for us a pretty comfortable and very much in line with where you see peers.

Hey guys. Good morning. Pat, just to clarify on the guidance on the NIM going forward, the expectations for pressure I assume that's on a GAAP basis including purchase accounting accretion and then -- I'm just curious on your thoughts on the core NIM going forward.

Sure, Nate. I think core will also likely contract, one -- there are couple of moving pieces in that -- one, we had not incorporated the impact of Bridgeview into our original guidance. Bridgeview will because of a difference in their mix and yields of their portfolio, will bring our margin down by kind of mid to high single digits over the course of the first two quarters, partly in Q2 and then more in Q3. The revised, our revised outlook on interest rates will also have an impact. And then, any increases in securities on balance sheet will also have a dilutive effect to margin, because clearly we're bringing those on at lower yields than our overall margin today.

Nathan Race -- Piper Jaffray -- Analyst

Understood. That makes sense. And then just kind of thinking about the trajectory of deposit cost from here. I guess, I was a little surprised to see the larger step-up in deposit costs this quarter versus what we saw throughout you know, the quarters in 2018. We've heard from some of your competitors in Chicago that we're seeing some easing in deposit pricing competition in the area. So just curious you know, how we should kind of think about the trajectory of deposit cost going forward assuming the Fed's on hold going forward.

Mark G. Sander -- President and Chief Operating Officer

Yeah, it's me -- we'll tag team this one Nate, it's Mark, we actually were kind of pleased with our deposit costs in Q1 they were -- while they rose about 11 basis points or 12 basis points overall, they actually rose less than we had forecasted.

Now, we're leaning more into CDs to fund ourselves and so that in itself is raising the cost a little bit. We don't see the pressures to increase them -- to increase deposit costs going forward, but again as that mix shifts a little bit more toward time, you might see the deposit costs rise a little bit from here.

Yeah. I'd just add that we continue to sort of price at market and are not really running any significant promotions other than CDs, which we continue to do, although we have shortened our duration, our current promotion is only for a ten-month CD, whereas for the last couple of years we had one and two-year.

Nathan Race -- Piper Jaffray -- Analyst

Pat, that's helpful. I appreciate the color.

Operator

(Operator Instructions). Our next question will come from Terry McEvoy of Stephens. Please state your question.

I guess just a question on Bridgeview. I know there were some closing conditions I believe on the national mortgage platform that needed to happen before the deal closed. Could you just give us an update on those closing conditions and whether you feel good with that May -- I think it was a May 9th closing date.

Yes. This is Mike. I'll just cut to the chase. All the closing conditions relative to the consummating the transaction are behind us. And all of those were resolved just as we hoped they would be. So there's no lingering impact from the sale of their mortgage operation or any of the other conditions that were out there.

Terry McEvoy -- Stephens -- Analyst

And then, Mike, while I've got you, the building out, call it a platform in Milwaukee I hadn't really thought about before, what do you have -- do you have anything up there? I think you mentioned private banking and is it overtime looking to add some commercial teams and build that into a newer banking market?

Well, it's certainly -- I'll let Mark offer greater color. It's certainly a natural extension of what we do. I mean recall, Northern States, further strengthened our platform in Lake County, Illinois where we're already pretty sizable. And that has a natural reach in the Southeast Wisconsin.

Northern Oak gives us a really talented wealth management group there and a lot of incremental contacts for purposes of organically expanding private banking and then certainly introduction from a commercial sales standpoint. Mark, why don't you add a little?

Mark G. Sander -- President and Chief Operating Officer

Yeah, I'd just say, we like that Southern Wisconsin market. We've been calling there from a commercial perspective for a number of years, but like all markets, it's local, and as much so as any markets candidly.

So we want to strategically expand on the ground as Mike indicated, Northern Oak gives us a great opportunity to establish a presence on the ground there and we think we can leverage it more broadly. We've got three commercial bankers on the ground in Wisconsin right now, presuming success which we anticipate, we soon would (ph) like to expand that and yes, I think private banking and then wealth management is our two avenues, but frankly all three of our lines of business consumer, commercial, and wealth we'd like to look to expand over time.

Terry McEvoy -- Stephens -- Analyst

And then Mark just one last question for you. The purchase of home equity loans one-to-four family mortgages, can you just talk about the longer term strategy, how large you'd like that portfolio to be, I assume, there is some national diversity and just kind of thoughts on the purchased aspect of it.

Mark G. Sander -- President and Chief Operating Officer

Yes. We've -- our consumer growth this quarter had a slow purchase (ph) activity, but a good amount of organic growth as well. As we think about it, we just evaluate both utilization of our liquidity, risk return, and diversification of markets and products.

We're still underweighted, we think in one to four as a Company. So not that we have to rush out to change that dynamic, but we think we have room to expand there as we see attractive risk return. And we would like to start to increase our fixed rate component of our book and so, we may look to do a little bit more of that over the next couple of quarters.

Terry McEvoy -- Stephens -- Analyst

Okay. Thanks everyone.

Operator

(Operator Instructions). If there are no further questions, I will now turn the call back over to Mr. Scudder for closing comments.

So, thank you. I won't reiterate what we've already covered. We just feel good about where we're at, we're excited about the quarter and the opportunities that lie ahead. I always like to take the opportunity to thank our colleagues, many of whom have the opportunity to listen to the call. I thank them for not only their contributions to our performance, their investment in what we do. They're the face of our Company and they deliver on the promise that we make to our clients every day.

With that, I'd also like to thank all of you for listening in and for your interest in and investment in First Midwest. Have a great day everybody.

Operator

Ladies and gentlemen this concludes the conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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